Many Australians enter the property market with some form of debt, whether it’s from student loans, personal loans, or credit cards. Fortunately, this doesn’t always disqualify them from securing a home loan. If you’re looking to buy a home, it’s crucial to understand how your existing debt affects your borrowing power and chances of loan approval.
In this guide, we’ll break down what borrowing power means and how various types of debt—like student loans, personal loans, and credit cards—can influence your capacity to secure a mortgage.
Understanding Borrowing Power
Borrowing power refers to the amount of money a lender is willing to approve for your home loan based on your current financial situation. Essentially, the stronger your borrowing power, the more lenders will trust you to handle a larger loan amount.
Factors that can boost your borrowing power include:
– A high income relative to your loan amount
– Stable employment
– Minimal debt
– A substantial deposit
– Assets and investments
– Reasonable living expenses
On the flip side, heavy debt, a poor credit history, or minimal savings can weaken your borrowing power, making it more challenging to qualify for a loan.
How Student Debt Impacts Borrowing Power
Many first-time homebuyers have student debt, and while this doesn’t usually prevent loan approval, it can lower your borrowing capacity. Lenders calculate your serviceability, or your ability to repay the loan, based on factors such as:
– The amount of student debt you carry
– Your income level
– Your profession
– Other existing debts
Each lender will assess these factors differently. Therefore, having student debt might not drastically reduce your chances of approval, but it will play a role in the overall evaluation of your financial situation.
Repaying HECS-HELP
HECS-HELP, Australia’s student loan program, operates differently from other forms of debt. Repayments are automatically deducted from your wages once your income hits a specific threshold, and there’s no interest charged—though it is subject to indexation.
Can You Get a Home Loan with HECS Debt?
Yes, having a HECS debt doesn’t automatically disqualify you from getting a home loan. Some lenders will consider it just like other debts, factoring it into your overall financial profile. However, you can take steps to improve your borrowing power if your student debt is impacting your loan prospects:
1. Paying off your HECS debt: This could delay your property purchase but may improve your loan application.
2. Increasing your income: Consider negotiating for a higher salary or taking on an additional job to strengthen your financial standing.
If your financial profile is otherwise strong, such as a stable income, a healthy credit rating, and minimal other debt, HECS debt may not be a major obstacle. For example, a young dentist with HECS debt may still have a high income that lenders find appealing. Want to check your HECS-HELP debt? Head to the myGov website.
The Impact of Personal Loans on Borrowing Power
Personal loans can reduce how much a lender is willing to approve for your mortgage, as these are seen as additional expenses you must manage each month. Since personal loans often come with higher interest rates, paying them off can take longer, which may reduce your overall borrowing power.
Strategies to Improve Borrowing Power
- Debt consolidation: This can simplify repayments and potentially reduce the impact of higher interest rates from multiple loans.
- Switching to a fixed interest rate: Lenders usually add a buffer to variable interest rates to account for potential future increases. By locking in a fixed rate, you may be able to avoid this buffer, increasing your borrowing power.
How Credit Cards Affect Borrowing Power
Even if you pay off your credit card balances every month, lenders may still view them as potential debt. For instance, if you have a credit card with a $3,000 limit, a lender could consider this as $3,000 in possible monthly debt.
To improve your borrowing power, consider the following:
- Cancel unused credit cards: If you don’t need your credit cards, cancelling them before applying for a home loan can boost your borrowing power.
- Reduce credit card limits: If you plan to keep your credit card, lowering the limit will reflect positively on your loan application.
Unpaid credit card debt can also significantly diminish your borrowing capacity, so paying off outstanding balances before applying for a mortgage is a smart move.
The Effect of Car Loans on Borrowing Power
Similar to personal loans, car loans often come with higher interest rates and can be seen as liabilities by lenders. If possible, paying off your car loan before applying for a home loan can strengthen your borrowing position. Demonstrating your ability to manage and repay debt can also enhance your credit score.
Opting for a fixed-rate car loan can be beneficial since it prevents lenders from applying a buffer for future interest rate increases.
Existing Home Loan Debt and Borrowing Power
Already owning a home with an existing mortgage can work in your favour when purchasing another property. If you have built equity in your current home, you can use it as a larger deposit for your next purchase, increasing your borrowing power. Additionally, if you receive rental income from investment properties, this can further boost your loan application.
Conclusion
Having existing debt doesn’t necessarily block you from buying a home. By understanding your borrowing power and taking proactive steps – like paying off debt or managing your credit – you can improve your chances of securing a loan. If you’re unsure about where to start, consulting with a mortgage broker can help you navigate your options and find the best path forward.
